Updated August 16, 2026
An installment sale is one where you receive the purchase price over time rather than all at closing, and it lets you recognize the capital gain as the payments come in rather than entirely in the year of sale. For an owner selling a long-held Los Angeles apartment building with a very low basis, that spreading can meaningfully reduce the tax rate applied to the gain by keeping income out of the highest brackets in any single year. It also makes you the lender, which is the part that deserves more attention than the tax benefit usually gets. Whether it is right for you depends on whether you want income and are willing to hold risk on the building, or whether you want to be finished with it.
Capital gain is recognized as principal is received. Each payment carries a proportional share of gain, return of basis, and interest.
Depreciation recapture generally is not deferred. The portion of the gain attributable to depreciation recapture is typically recognized in the year of sale, regardless of how little cash you received. On a fully depreciated LA building this can be a large number, and it is the single most common unpleasant surprise in an installment sale — the seller owes tax in year one on money they will not receive for years.
Interest is ordinary income. The interest component of each payment is taxed as ordinary income, not capital gain.
Measure ULA and California withholding still apply at the transfer. ULA is a transfer tax on the gross price and is due at closing. California withholding rules apply to installment payments through their own reporting mechanism.
That combination — recapture due up front, transfer tax due up front, cash arriving over years — is exactly why the structure has to be modeled before it is agreed to.
Bracket management. Spreading a very large gain over several years can keep more of it out of the top rates.
Yield. A note at a market rate on a building you know intimately, secured by that building, can be an attractive place for capital — particularly for a seller who does not want the reinvestment problem.
It expands the buyer pool. In a tight financing market, seller carryback is sometimes what makes a deal possible at all, and buyers will pay for the accommodation.
It can bridge a valuation gap. Structuring part of the price as a note, sometimes with terms tied to performance, can close a distance that cash alone would not.
You still own the risk. If the buyer stops paying, your remedy is foreclosure — on a building you just sold, possibly in worse condition than when you left it, with tenants you no longer know.
Buyer quality becomes everything. You are underwriting a borrower. Experience, net worth, liquidity, and how much equity they actually put in matter far more than they would in an all-cash sale.
Your capital is not liquid. It cannot fund a 1031 replacement purchase, a retirement plan, or a family distribution.
Interest rate risk runs against you. A note written at today's rate may look poor in five years, and you cannot easily exit it.
It complicates a 1031 exchange. An installment note is generally not like-kind property. Combining a carryback with an exchange is possible in limited ways but requires careful structuring — this is specialist territory.
Secure it with a recorded deed of trust on the property. An unsecured note on a multimillion-dollar building is not an acceptable position.
Require meaningful buyer equity. The larger the buyer's down payment, the less likely you are to end up owning the building again. This is the single most important protection.
Underwrite the borrower as a lender would. Financial statements, references, a track record of operating similar buildings in Los Angeles.
Set real terms. Market interest rate, defined amortization, a definite maturity, and a due-on-sale provision. Open-ended terms create problems for both sides.
Model the year-one tax before you agree. Recapture plus ULA plus closing costs against a small down payment can produce a year in which the tax owed exceeds the cash received. Your CPA should run that arithmetic before the deal is structured, not after.
An installment sale is a genuine tool for a seller with a large gain who wants income rather than a lump sum and is comfortable holding risk on the building. It is the wrong tool for a seller who wants to be finished, who needs liquidity, or who is planning a 1031 exchange. Before agreeing to anything, have your CPA model the first-year tax including depreciation recapture and Measure ULA against the actual cash you will receive at closing — that single calculation resolves most of these decisions.
Can I do an installment sale and a 1031 exchange together?
In limited ways, with careful structuring, because a note is generally not like-kind property. It is possible in some configurations but it is specialist work and it has to be designed before the transaction, not retrofitted afterward.
What happens if the buyer defaults?
You pursue your remedies under the deed of trust, which typically means foreclosing and potentially taking the building back — often in poorer condition and with a tenant situation you have not managed for years. This is the risk the buyer's down payment and your underwriting are meant to protect against.
Is depreciation recapture really due right away?
The recapture portion of the gain is generally recognized in the year of sale rather than spread over the installments. On a long-held, fully depreciated building that is a significant amount, and it is the reason a low down payment can create a year where the tax exceeds the cash.
Michael Sterman is Senior Managing Director Investments at Marcus & Millichap.
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